Interest rates affect the ability of consumers and businesses to

access credit
By JAMES GARRETT BALDWIN
 Updated Mar 16, 2020
TABLE OF CONTENTS
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 Interest Rates and Borrowing

 The Prime Rate 
 Credit Card Rates
 Savings 
 U.S. National Debt 
 Business Profits
 Auto Loan Rates
 Mortgage Rates
 Home Sales
 Consumer Spending
 Inflation
 Best Stocks When Rates Rise
 The Bottom Line

On September 18, 2019 the Federal Reserve cut the target range for its
benchmark interest rate by 0.25%. It was the second time the Fed cut rates in
2019 in an attempt to keep the economic expansion from slowing amid many
signs that the slowdown is well under way. Then, at the beginning of the
global coronavirus pandemic, the Fed cut interest rates further on March 15,
2020 in a dramatic move to near 0%.

Why does the Fed cut interest rates when the economy begins to struggle or
raise them when the economy is booming? The theory is that by cutting rates,
borrowing costs decrease which prompts businesses to take out loans to hire
more people and expand production - and the logic works in reverse when the
economy is hot. Here, we take a look at the impact on various parts of the
economy when the fed changes interest rates, from lending and borrowing to
consumer spending to the stock market.

When interest rates change , there are real-world effects on the ways that
consumers and businesses can access credit to make necessary purchases and
plan their finances. It even affects some life insurance policies. This article
explores how consumers will pay more for the capital required to make
purchases and why businesses will face higher costs tied to expanding their
operations and funding payrolls when the Federal Reserve changes the interest
rate. However, the preceding entities are not the only ones that suffer due to
higher costs, as this article explains.

KEY TAKEAWAYS

 Central banks cut interest rates when the economy slows down in order to
re-invigorate economic activity and growth.
 The goal is to reduce the cost of borrowing so that people and companies
are more willing to invest and spend.
 Interest rate changes spill over to many facets of the economy, including
mortgage rates and home sales, consumer credit and consumption, and
stock market movements.
Interest Rates and Borrowing
Lower interest rates directly impact the bond market, as yields on everything from
U.S. Treasuries to corporate bonds tend to fall, making them less attractive to
new investors. Bond prices move inversely to interest rates, so as interest rates
fall, the price of bonds rise. Likewise, an increase in interest rates sends the price
of bonds lower, negatively impacting fixed-income investors. As rates rise,
people are also less likely to borrow or re-finance existing debts, since it is more
expensive to do so.

The Prime Rate 

A hike in the Fed's rate immediately fueled a jump in the prime rate (referred to
by the Fed as the Bank Prime Loan Rate), which represents the credit rate that
banks extend to their most credit-worthy customers. This rate is the one on which
other forms of consumer credit are based, as a higher prime rate means that
banks will increase fixed, and variable-rate borrowing costs when assessing risk
on less credit-worthy companies and consumers. 

Credit Card Rates

Working off the prime rate, banks will determine how creditworthy other
individuals are based on their risk profile. Rates will be affected for credit cards
and other loans as both require extensive risk-profiling of consumers seeking
credit to make purchases. Short-term borrowing will have higher rates than those
considered long-term.

Savings 
Money market and certificate of deposit (CD) rates increase due to the tick up of
the prime rate. In theory, that should boost savings among consumers and
businesses as they can generate a higher return on their savings. On the other
hand, the effect may be that anyone with a debt burden would instead seek to
pay off their financial obligations to offset the higher variable rates tied to credit
cards, home loans, or other debt instruments.

U.S. National Debt 

A hike in interest rates boosts the borrowing costs for the U.S. government,
fueling an increase in the national debt. A report from 2015 by the Congressional
Budget Office and Dean Baker, a director at the Center for Economic and Policy
Research in Washington, estimated that the U.S. government may end up paying
$2.9 trillion more over the next decade due to increases in the interest rate, than
it would have if the rates had stayed near zero. 

Business Profits
When interest rates rise, its usually good news for banking sector profits since
they can earn more money on the dollars that they loan out. But for the rest of
the global business sector, a rate hike carves into profitability. That’s because the
cost of capital required to expand goes higher. That could be terrible news for a
market that is currently in an earnings recession. Lowering interest rates should
be a boost to many business' profits as they can obtain capital with cheaper
financing and make investments in their operations for lower cost.

Auto Loan Rates

Auto companies have benefited immensely from the Fed’s zero-interest-rate
policy, but rising benchmark rates will have an incremental impact. Surprisingly,
auto loans have not shifted much since the Federal Reserve's announcement
because they are long-term loans. In theory, lower interest rates on auto loans
should encourage car purchases, but these big ticket items may not be as
sensitive as more immediate needs borrowing on credit cards.

Mortgage Rates
A sign of a rate hike can send home borrowers rushing to close on a deal for
a fixed loan rate on a new home. However, mortgage rates traditionally fluctuate
more in tandem with the yield of domestic 10-year Treasury notes, which are
largely affected by interest rates. Therefore, if interest rates go down, mortgage
rates will also go down. Lower mortgage rates means it becomes cheaper to buy
a home.

Home Sales
Higher interest rates and higher inflation typically cool demand in the housing
sector. For example, on a 30-year loan at 4.65%, home buyers can anticipate at
least 60% in interest payments over the duration of their investment. But if
interest rates fall, the same home for the same purchase price will result in lower
monthly payments and less total interest paid over the life of the mortgage. As
mortgage rates falls, the same home becomes more affordable - and so buyers
should be more eager to make purchases.

Consumer Spending
A rise in borrowing costs traditionally weighs on consumer spending. Both higher
credit card rates and higher savings rates due to better bank rates provide fuel a
downturn in consumer impulse purchasing. When interest rates go down,
consumers can buy on credit at lower cost. This can be anything from credit card
purchases to appliances purchased on store credit to cars with loans.

Inflation
Inflation is when the general prices of goods and services rise in an economy,
which may be caused by a nation's currency losing value or by an economy
becoming over-heated -- i.e. growing so fast that demand for goods is outpacing
supply and driving up prices. When inflation rises, interest rates are often
increased as well, so that the central bank can keep inflation in check (they tend
to target 2% a year of inflation). If, however, interest rates fall, inflation can begin
to accelerate as people buying on cheap credit can begin bidding up prices once
again.